1989 Report of the Auditor General of Canada

Main Points

4.1 The Audit Notes chapter fulfils a special role in the annual report. Other chapters normally describe the findings of the comprehensive audits we perform in particular departments; or they report audits and studies of issues that relate to government operations as a whole. The Audit Notes chapter brings together in one place individual matters that have come to our attention during our financial audits of the Public Accounts of Canada, Crown corporations and other entities. It is also used to report some individual matters that have come to our attention during the performance of our comprehensive audits.

4.2 Where, in the Auditor General's judgment, these matters are of significance and of a nature that they should be brought to the attention of the House of Commons, the Auditor General Act requires him to include them in his annual report.

4.3 The Audit Notes chapter is, therefore, a compilation of these instances.

4.4 This year's chapter contains a wide range of notes. Three relate to Crown corporations and other entities, and the balance to departmental operations. Several involve large expenditures of public moneys.

4.5 While the notes report matters of significance, they should not be used as a basis for drawing wider conclusions about matters we did not examine.

Introduction

4.6 This chapter contains matters of significance that we believe should be drawn to the attention of the House of Commons. They have not been reported elsewhere in the report, but have come to our attention during our audits of the accounts of Canada, Crown corporations and other entities or during the performance of our comprehensive audits.

4.7 Section 7(2) of the Auditor General Act requires the Auditor General to call Parliament's attention to any significant cases where he has observed that:

(a) accounts have not been faithfully and properly maintained or public money has not been fully accounted for or paid, where so required by law, into the Consolidated Revenue Fund;

(b) essential records have not been maintained or the rules and procedures applied have been insufficient to safeguard and control public property, to secure an effective check on the assessment, collection and proper allocation of the revenue and to ensure that expenditures have been made only as authorized;

(c) money has been expended other than for purposes for which it was appropriated by Parliament;

(d) money has been expended without due regard to economy or efficiency; or

(e) satisfactory procedures have not been established to measure and report the effectiveness of programs, where such procedures could appropriately and reasonably be implemented.

4.8 Each of the matters of significance reported in this chapter was examined in accordance with generally accepted auditing standards, and accordingly our examinations included such tests and other procedures as we considered necessary in the circumstances. The matters reported should not be used as a basis for drawing conclusions about matters not examined. The instances that we have observed are described in this chapter under the appropriate Crown corporation, department or agency heading.

Observations on Crown Corporations and Other Entities

4.9 The Auditor General is appointed auditor of a number of Crown corporations and other entities, under the Financial Administration Act, individual Acts incorporating specific corporations or by Orders in Council. Details of significant reservations and other matters contained in reports issued to these corporations and entities during the year are set out below. Most of these matters have already been raised in a public forum, but they are reported here for emphasis and for consideration by Parliament.

Government of Canada - The Government has Issued, Without Proper Authority, a Letter of Comfort Guaranteeing $3.7 Billion of the Canadian Wheat Board's Receivables

In 1972, the Government issued a letter assuring the Canadian Wheat Board (CWB) that its receivables arising from export credit sales of grain were guaranteed by the government in the event of buyer default. To give such a guarantee requires the authority of Parliament, and no such authority has ever been sought. As a result of this letter, the Board has distributed at least $1.5 billion of "surpluses on operations" to producers, and the government has accumulated a contingent liability of up to $3.7 billion. Currently, the Board is carrying $3.2 billion in loans that are troubled.

By failing to seek Parliament's authority to guarantee the Board's receivables, as is explicitly required by section 29 of the Financial Administration Act, the Government has denied Parliament its right of prior approval before commitments are made. This has left Parliament in the situation of being asked to approve an expenditure long after the liability has been incurred and without the opportunity to consider alternative courses of action.

4.10 The Canadian Wheat Board Act (CWBA) gives the Canadian Wheat Board the authority to borrow funds. It also gives the government the authority to guarantee to the Board's creditors repayment of their funds in the event that the Board is unable to repay its borrowings. These guarantees are reviewed regularly on a country and amount specific basis by Cabinet.

4.11 In 1971 the Board became concerned that, in the event that its debtors were to default on their loans, the Board would in turn be unable to pay its obligations. The Board was of the view that the Government was committed to assuming the risk of non-payment by the Board's debtors, and asked that this commitment be expressed formally.

4.12 The Government considered the matter in 1972. To give the assurance that the Board wished would in effect be to guarantee to the Board its receivables in the event one of its debtors were to default. The authority to give such a guarantee can only be given by an Act of Parliament. Documents we reviewed confirm that the Government was fully aware of this. However, a decision was made by Cabinet to have the then Minister for the Canadian Wheat Board write to the Board and assure it that there is no question that the government is liable for the risk of non-payment by the purchaser. The letter was sent on 4 May 1972. The Board is of the view that this letter represents a binding commitment on the government to guarantee its receivables and it cites a recent Federal Court of Appeal decision in its support. This commitment has been reaffirmed on subsequent occasions by Cabinet, most recently in 1987. Despite the fact that the CWBA has been amended on several occasions since 1972, no Parliamentary authority has been sought for this guarantee.

4.13 The CWBA requires that the Board receive payment in full for the grain it has sold before it pays the "surpluses on operations" from these sales to producers. However, in 1979 some of the Board's debtors began to default on their loans. Currently, the Board is carrying $3.2 billion in loans that are troubled, and the value of these loans is, in our opinion, impaired by at least $1.5 billion (see Chapter 2, paragraphs 2.41 to 2.56). Nonetheless, based on this guarantee of its receivables, the Board believed that, for all intents and purposes, it had sufficient assurance of receiving "payment in full" that it could proceed with making the distributions of the surpluses on operations to producers.

4.14 The consequences of this are that, under this guarantee issued without proper authority, at least $1.5 billion of surpluses on operations have been distributed to producers and the government has incurred a contingent liability to the Crown of up to $3.7 billion, the amount of the Board's receivables. This has been done without Parliament's authority.

4.15 The Wheat Board's receivables and the accrued interest on them have grown over the years to a very large sum that continues to grow at a rate of several hundred million dollars a year. Sooner or later, Parliament is likely to be asked to authorize payment from the Consolidated Revenue Fund to cover some or all of the payments which would be required under a guarantee of the receivables. By failing to seek Parliament's authority to guarantee the Board's receivables, as is explicitly required by section 29 of the Financial Administration Act, the Government has denied Parliament its right of prior approval before commitments are made. This has left Parliament in the situation of being asked to approve an expenditure long after the liability has been incurred and without the opportunity to consider alternative courses of action.

4.16 We wrote government officials but, at the time of going to press, we did not have a reply. However, there were indications that we might expect corrective action soon. We will continue to monitor the situation.

Export Development Corporation - Inadequate Recognition of Sovereign Risk

Many lesser developed countries are continuing to experience difficulties in repaying loans as they become due. The auditor's report on the financial statements of the Export Development Corporation (EDC) for the year ended 31 December 1988 was qualified because of a departure from generally accepted accounting principles (GAAP). The Corporation had $4.726 billion in sovereign loans, against which a general allowance for losses of $107.8 million on loans was recorded on the balance sheet. We believe that this allowance is inadequate to recognize the sovereign risk involved.

4.17 In our opinion, loans receivable are overvalued because the Corporation's estimate of the allowance for losses on loans is significantly understated. It therefore does not conform to generally accepted accounting principles. Although the scope of our examination was adequate to arrive at this conclusion, we could not determine the precise magnitude of the overstatement of loans receivable. This is the Corporation's responsibility. Its current methodology for estimating an appropriate allowance for losses on loans is inadequate, in our view. The Corporation does not quantify the allowance for sovereign risk by country, for financial statement purposes, based on an assessment of the ability and willingness of the country to repay its debt. In addition, the methodology does not result in a documented link to existing economic and political analyses of sovereign risk. In our opinion, prompt remedial action is needed to implement an adequate methodology for recognizing sovereign risk and to arrive at an appropriate allowance for losses on sovereign loans.

4.18 If an appropriate allowance had been established, the provision for losses on loans would have been significantly increased; net income reported by the Corporation would have become a significant loss for the year; and retained earnings would likely have become a deficit.

4.19 The Board of Directors and management are in fundamental disagreement with the Auditor General's opinion. In particular, EDC disagrees with the view that, in the case of some of its loans, the principal may not be ultimately collectible in full. EDC has pointed out that the Government of Canada, as stated in its accounting policies in the Public Accounts, shares EDC's views on accounting for sovereign loans. However, the Auditor General disagrees with the Government of Canada's accounting policy. The Auditor General has also qualified his opinion on the Public Accounts of Canada with respect to inadequate recognition of sovereign risk.

Farm Credit Corporation - Decision to Delay Special Examination Beyond Statutory Deadline

The Farm Credit Corporation (FCC) has decided to defer the completion of a special examination of its systems and practices to a date that is after the deadline established by Part X of the Financial Administration Act.

4.20 Sub-section 138(1) of Part X of the Financial Administration Act (FAA) requires that specified Crown corporations cause a special examination to be carried out. The purpose of the special examination is to determine whether the corporation has maintained systems and practices in a manner that provided reasonable assurance that:

• the assets of the corporation were safeguarded and controlled;
• the resources of the corporation were managed economically and efficiently; and
• the operations of the corporation were carried out effectively.

4.21 The FAA also requires that a special examination of each specified corporation be carried out at least once every five years. The deadline for completion of the first round of special examinations is 1 September 1989.

4.22 The Farm Credit Corporation has recently undergone a period of considerable change, partly in response to the substantial losses it has incurred in recent years. In the year ended 31 March 1988, the Corporation incurred a loss of $512 million, bringing its accumulated deficit to $855 million. At 31 March 1989, the accumulated deficit had increased to $890 million. In the summer of 1988, Cabinet approved a recovery plan for the Corporation. In response, FCC initiated a number of significant changes to its systems and practices. It then concluded that these changes brought into question the value to its Board of a special examination of its prior methods but that an early review of its new systems would be very valuable.

4.23 Accordingly, FCC's Board decided on 15 December 1988 that December 1990 be established as a target date for completion of the special examination. While this was a justifiable decision from management's point of view, it is not in accordance with Part X of the FAA which requires that the special examination be completed by 1 September 1989.

4.24 The audit report issued by the Auditor General in connection with the Farm Credit Corporation's financial statements as at and for the year ended 31 March 1989 has been qualified to reflect the Board's decision to defer the completion of the special examination which is contrary to Part X of the FAA.

International Centre for Human Rights and Democratic Development - Inability of the Centre to Prepare and Provide Financial Statements for Audit

Because no one has been appointed to represent the International Centre for Human Rights and Democratic Development, no annual report or financial statements have been prepared for the year ended 31 March 1989 as required by the Centre's incorporating Act. We have, therefore, been unable to conduct an audit, as required under Section 31 of the Act.

4.25 In September 1988, the International Centre for Human Rights and Democratic Development was established as a corporation by an Act of Parliament. Section 31 of the Act requires that, within four months after the end of each fiscal year, the Chairman of the Corporation transmit to the Minister (External Affairs) a report on the activities of the Centre for that fiscal year, including its financial statements and the Auditor General's audit opinion thereon.

4.26 As section 28 of the Act requires that the Centre be paid $1 million out of the Consolidated Revenue Fund in the fiscal year ended 31 March 1989, the Canadian International Development Agency (CIDA) issued a cheque dated 26 March 1989 for this amount, payable to the Centre. No one representing the Centre was available to receive the funds.

4.27 As of 31 July 1989, no chairman, director or employee of the Centre had been appointed or hired. As a result, not only did the cheque remain unclaimed from CIDA, but also no annual report or financial statements have been prepared as required by the Act.

4.28 We have, therefore, been unable to audit the Centre's financial accounts and transactions as required by section 31 of the Act.

Observations on Departmental Operations

Atlantic Canada Opportunities Agency - Failure to Include Restrictive Performance Clauses in a Contribution Agreement as Contemplated in Ministerial Approval

When it entered into a repayable contribution agreement to assist a company's research and development program, the Atlantic Canada Opportunities Agency (ACOA) failed to include restrictive performance clauses requiring the company to carry out at least $12 million of the program in a new facility in Sydney, Cape Breton. Ministerial approval for the assistance was given on the understanding that these clauses would be included. The absence of restrictive performance clauses allowed the company to carry out the research and development program at its other facilities outside Atlantic Canada.

4.29 The Atlantic Canada Opportunities Agency's objective is "to support and promote opportunity for economic development of Atlantic Canada ...".

4.30 In 1988 ACOA entered into a repayable contribution agreement, under the ACOA Action Program, to assist a recipient in carrying out a research and development program costing $24 million. Ministerial authority was given for the agreement on the understanding that $12 million of the program costs would be incurred at a new facility in Sydney, Cape Breton. The ACOA contribution was to be 60 percent of actual eligible costs to a maximum of $9 million.

4.31 The performance clauses in the signed agreement did not include a reference to the $12 million allocation for the Sydney facility and required the recipient to make only "best efforts" to purchase from Atlantic Canada suppliers.

4.32 The failure to include these restrictive performance clauses permitted the recipient to direct the research and development activities to its other facilities outside Atlantic Canada.

4.33 Senior management has informed our Office of its intention to renegotiate the agreement, to better reflect the performance clauses contemplated in the ministerial approval.

Department of Agriculture - Contribution Payment in Advance of Need

A $1.2 million contribution payment was made to the Province of Quebec in March 1988. In our opinion, $600,000 of this amount was paid in advance of need, resulting in additional financing costs to the government of some $50,000. This represents poor cash management and is inconsistent with Treasury Board guidelines on contribution payments.

4.34 Order in Council P.C. 1986-1/2747 provided authority (pursuant to section 5 of the Department of Agriculture Act) to the Minister of Agriculture to enter into the Canada-Quebec Agri-Food Development Subsidiary Agreement for 1987-90. Under the Agreement, Canada and the Province of Quebec agreed to share equally the costs of programs and projects set out in the Agreement up to a maximum contribution by each government of $17.5 million.

4.35 One of the projects was a $3 million inventory of soil degradation problems for which the Province of Quebec submitted partial costs of $1.2 million in March 1988. The Department, judging that the project would ultimately be completed and the $1.2 million eventually payable, reimbursed the Province for the full $1.2 million. This represented a payment in advance of need of $600,000 -- funds which the government did not yet owe and which would otherwise have lapsed.

4.36 According to Treasury Board guidelines on grants, contributions and other transfer payments, "... a contribution paid in advance of need effectively costs the government more than the face value of the payment since interest and financial costs need to be taken into account".

4.37 Based on the estimated dates that the payments might otherwise have been due, and calculating interest at the 90-day Treasury Bill rate, the government's financing cost on the $600,000 paid in advance of need was approximately $50,000.

Department of Agriculture - Erosion of Accountability and of Parliamentary Control

The Department of Agriculture has made extensive use of section 5 of the Department of Agriculture Act and Governor in Council authority to create new programs. The Act conveys broad powers to the Minister and Governor in Council, which the Department has used frequently to set up new programs involving billions of dollars. Information presented to Parliament on the objectives and impacts of these programs is inadequate. In at least one case (a program involving $1 billion), a departmental evaluation indicated that the program may have been ill-conceived. Had legislation been introduced to establish the program, with an opportunity for Parliament to consider and debate its purpose, a better-designed program might have resulted.

4.38 Section 5 of the Department of Agriculture Act provides that the "Governor in Council may assign any other power or duty to the Minister". The Department has used this provision in recent years to create or amend dozens of programs that have no other basis in legislation. For example, in the year ended 31 March 1989, at least 22 Orders in Council were passed pursuant, in whole or in part, to section 5 of the Act. These Orders in Council authorized or amended 12 programs involving some $120 million. (In 1987-88, at least 19 Orders in Council dealt with 8 programs representing $153 million.) Payments made under individual programs range from a few thousand dollars to many millions of dollars.

4.39 Another major government department had a similar provision in its Act until 1927 when it was removed by Parliament on the basis that it was unnecessary in view of provisions in the Public Service Rearrangement and Transfer of Duties Act (PSRTDA). These provisions authorize the Governor in Council to transfer powers, duties or functions of any part of the public service from one minister or department to another. The PSRTDA does not say, however, that the Governor in Council has the authority to create powers or programs. In our opinion, this is a prerogative of Parliament which is being eroded when section 5 of the Department of Agriculture Act is used to create major programs.

4.40 In using section 5 of the Act in this way, although the Department notes that it has complied with all government requirements for proper disclosure, the result is that Parliament is provided with little specific information on significant departmental programs. Parliament has little opportunity to debate them, and little basis for monitoring and controlling them, even though it is being asked to vote moneys to fund them.

4.41 In our 1987 Report, we questioned the Department's use of section 5 to create the $1 billion 1986 Special Canadian Grains Program. The 1986 Program was followed by the 1987 Special Canadian Grains Program, involving $1.1 billion, and the Crop Drought Assistance Program at $850 million. These three programs, totalling almost $3 billion, and other programs authorized in this way, are not adequately supported by legislation that establishes their objectives, policy and administrative frameworks, terms and conditions and eligibility criteria. Most importantly, they were established without Parliament having had the opportunity to fully debate them. We should note that approval of the necessary funding through the Estimates process was sought by the Department. However, in our view, hearings on the Estimates are designed to give approval to spend money for purposes and programs that have already been properly debated in the legislative process. Accordingly, they do not provide for the extensive and searching scrutiny of programs that the legislative process does. Indeed, the Speaker of the House of Commons, on 22 March 1977, noted as follows:

...it is my view that the government receives from Parliament the authority to act through the passage of legislation and receives the money to finance such authorized action through the passage by Parliament of an appropriation act. A supply item in my opinion ought not, therefore, to be used to obtain authority which is the proper subject of legislation.

4.42 A departmental study, entitled "The Interface Between Stabilization and Special Assistance Programs in the Canadian Grain Sector", of the 1986 Special Canadian Grains Program (SCGP) indicated that there were significant flaws in the way the program had been designed and implemented. For example, the study points out that the program provided for payments based on the "degree of injury". However, it goes on to point out that, "This degree of injury is less after stabilization payments have been factored in, but [in the case of this program] was measured prior to such stabilization. Once WGSA and ASA [Western Grain Stabilization Act and Agricultural Stabilization Act] payments have been received, the degree of injury may not have been below the safety net level". Indeed, the program may not have been needed at all. In response to the question, "Was a 1986-87 SCGP needed?" the study responds, "In 1986, stabilized prices were close to or over the safety net, if this is defined as 120 percent of cash costs. Compensation in this case may not have been needed for the 1986 crop". Had Parliament had the opportunity to fully debate this extensive program, some of these points might have been brought out before the program was implemented.

4.43 We are also concerned about the use of section 5 to provide assistance of up to $5.3 million to producers of red delicious apples. The terms of the Agricultural Stabilization Act (ASA) preclude stabilization payments beyond those provided by a tripartite stabilization plan authorized by the Governor in Council on 18 June 1987. Nevertheless, the Department made additional payments to these producers by creating a program pursuant to section 5. In effect, in this instance, the Department has used the broad authority given in section 5 of the Act to do something disallowed by more specific and more recent legislation.

4.44 With respect to the assistance payments to red delicious apple producers, the Department replies that, while it agrees with our interpretation of the ASA, the ASA does not preclude any other assistance which could be afforded under other legislation. However, in its discussion of the reasons for the payment, it is clear that the intent of the payment was price stabilization, based on the view that the tripartite level of stabilization was not adequate in these particular circumstances. The use of section 5 of the Department of Agriculture Act to make these payments, whether technically legal or not, circumvents Parliament's requirement, as expressed in the ASA, that there be no further price stabilization payments if a tripartite agreement is in place for the commodity.

4.45 The Department has also pointed out that its legal advisers have indicated that, in their opinion, section 5 of the Department of Agriculture Act provides an adequate legal basis for the actions described. However, we must note that our primary concern is not with the narrow legality of the Department's use of this provision but rather with its impact on Parliament's ability to carry out its role.

4.46 There have not been any significant amendments to the Department of Agriculture Act for many years. In our view, the government's extensive and varied use of section 5 of the Act presents a threat to Parliament's role. Parliament should be given the opportunity to review the Act and decide whether section 5 should continue to be used in this manner.

Department of Agriculture - Tripartite Program for Sugar Beets is not Meeting the Legal Requirement to be Financially Self-sustaining

In our opinion, the National Tripartite Price Stabilization Program for sugar beets is not financially self-sustaining, although it is required to be by the Agricultural Stabilization Act. Furthermore, there are serious deficiencies in the Department's analyses of the program's viability. Information presented to the Minister of Finance when advances were requested to meet funding shortfalls was inadequate.

The Tripartite Stabilization Programs

4.47 The Department of Agriculture has established Tripartite Stabilization Programs for various agricultural commodities to stabilize the receipts of participating producers. This is in part accomplished through stabilization payments made to producers when the average market price of the commodity falls below a calculated support price. The programs are established and operate under the authority of the Agricultural Stabilization Act, Governor in Council approvals and agreements between Canada and participating provinces. Funding of the programs is shared equally by Canada, participating provinces and participating producers subject to maximum contribution levels by Canada and the provinces. A Stabilization Committee, made up of federal, provincial and producer representatives, has been established for each program.

4.48 The Act requires that the level of premiums paid by producers must be such as will, along with government contributions and interest received, make each program financially "self-sustaining". The agreements have defined this to mean that, over time, premiums, government contributions and interest received should equal stabilization payments and interest paid.

Financial Situation of Sugar Beet Program

4.49 In our opinion, the sugar beet program is not financially viable under the existing arrangements nor is it likely to be so, given current forecasts. In its first year of operation, covering the 1987 crop, revenues (producer premiums plus federal and provincial contributions) totalled $2.5 million but stabilization payments amounted to $14.5 million, resulting in a deficit of $12 million, averaging over $12,000 for each participating producer. Based on preliminary departmental forecasts, after the 1988 crop, the accumulated deficit, including interest charges on the previous deficit, will be approximately $17 million.

Minister of Finance's Concerns

4.50 In authorizing advances to the sugar beet tripartite program to cover funding deficiencies, the Minister of Finance also expressed concerns, on two separate occasions, about the viability of the program. In approving the second advance, he noted that "until the actuarial soundness of the sugar beet plan is confirmed..., it would be extremely difficult for me to justify the provision of any future advances to this program".

Departmental Analysis of Financial Viability

4.51 We share the Minister of Finance's concerns and are also concerned about what we believe to be serious deficiencies in the Department's earlier analyses of the program's viability. Such analyses are fraught with all the difficulties of trying to predict the future. This is even more difficult in the context of the extremely volatile market for sugar beets in the past decade. For example, Canadian prices for sugar have ranged from $80 per tonne in 1979 to $25 per tonne in 1986. In our view, this emphasizes the need for conservatism in assumptions and predictions and for sensitivity analysis of the various assumptions, including an analysis of worst- and best-case scenarios.

4.52 We have reviewed earlier departmental analyses which concluded that the tripartite program for sugar beets had the potential to be viable by 1996. These were based on very optimistic assumptions and did not adequately consider the unique nature of the various market forces affecting sugar beet prices. For example, these analyses generally assumed that historical price patterns would repeat in the next decade and, therefore, projected prices of over $70 per tonne for 1989 and about $60 per tonne for 1990. In early 1989, world prices ranged from $30 to $40 per tonne. Another of the many assumptions is that costs of production will be affected by one percent inflation per year. The Department's own data indicate that, in recent years, costs of production for sugar beets have risen by an average of 7.2 percent each year. More recent departmental analyses undertaken in the spring and summer of 1989 have used more varied and realistic assumptions and have arrived at less optimistic conclusions.

Stabilization Payment Rate for 1987 Sugar Beets

4.53 We are also concerned about the unusual way the stabilization payment rate was calculated for the 1987 sugar beet crop -- one of the major causes, in our view, of the program's current financial difficulties. The agreement requires that the calculation be based on the "current cash costs of production". Calculating the costs of production involves converting costs per acre to costs per standard tonne. For 1987, the Department based its calculation on costs per acre for 1987 and average yield from 1982 to 1986 -- a cost of production based on costs in one year and yields in others. This resulted in stabilization payments based on production costs of $660 per acre, when in fact the current cost per acre has been estimated at $470. Had the 1987 yield been used, stabilization payments totalling $14.5 million would have been reduced to $6.6 million.

4.54 In the view of departmental officials, the use of a five-year average yield is an integral part of the cost-of-production model which the Stabilization Committee has the authority to establish and amend. In our view, however, the agreement requires that the model use current costs of production, which must be determined on the basis of current yields if the results are to be meaningful.

Conclusions

4.55 Based on our review of the Department's viability analyses and our own analyses, we have concluded that the sugar beet program is not self-sustaining. Information presented to the Minister of Finance when advances to the program were sought was inadequate. In our view, the Department's analyses of the program's viability were deficient in a number of important respects and the Department had not adequately considered how to restore the viability of the program.

4.56 We have reviewed the Department's analyses of financial viability for only the sugar beet tripartite program. In light of the size and number of tripartite and other stabilization programs, we are considering undertaking a more comprehensive review of the Department's stabilization programs in future years.

Department of the Environment - Lack of Expenditure Authority

The Canadian Parks Service (CPS) does not have the authority under the Historic Sites and Monuments Act to spend funds for the display and administration of the St. Roch Historic Site in Vancouver. In recent years, CPS has spent in excess of $200,000 annually on this site. The St. Roch, a former Royal Canadian Mounted Policy supply vessel, is known for its 1942 voyage through the Northwest Passage. It is now owned by the City of Vancouver and is designated a National Historic Site by CPS.

4.57 In 1965 an agreement was signed between CPS and the City of Vancouver which stipulated that CPS would restore and furnish the vessel and the City would assume responsibility for its display, care, supervision and protection.

4.58 The Canadian Parks Service has stated that in 1974, the year the site was opened to the public, the City indicated that it could not afford to display the vessel. The Canadian Parks Service assumed this responsibility, and has continued its financial and operational support ever since. Under the Historic Sites and Monuments Act, CPS may only spend money on sites which it owns or for which it has received Governor in Council authority. In effect, CPS has accepted responsibility for all maintenance associated with the vessel and its shelter, acquisition and maintenance of the vessel's furnishings, janitorial services, monitoring and repair of the fire and intrusion systems, guide services, a share of the educational literature associated with the vessel and all visitor services and surveillance within the vessel shelter. The City maintains the grounds and parking lot, provides light and heat for the shelter, and provides office and work space for staff and washroom facilities for staff and the public.

4.59 The Canadian Parks Service continues to pursue alternatives for the display of this historic site that could lead to the resolution of the authority issue.

Department of External Affairs - Insufficient Disclosure to Parliament of Planned Expenditures on Export Trade

The government's expenditures on international trade are made in a number of ways. One way is through the "Canada Account" included in the books and records of the Department of External Affairs and administered by the Export Development Corporation (EDC). In our view, Parliament is not given enough information to understand the nature, purpose and magnitude of planned expenditures on export trade relating to the Canada Account. Plans submitted to Parliament by the Department of External Affairs and EDC do not contain explanations of costs and intended benefits of these trade related expenditures, and we could not determine which government organization is accountable for justifying decisions or for their results.

4.60 Part II of the Estimates for the Department of External Affairs indicates that the planned levels of disbursements through the Canada Account are $176 million for 1988-89 and $225 million for 1989-90. This represents a significant portion of government expenditures on international trade development.

4.61 The Export Development Act provides for loans, insurance and guarantees for the purpose of facilitating and developing export trade. Contracts which, in the opinion of EDC's Board of Directors, involve risks for a term or an amount in excess of that "normally" undertaken by the Corporation, may be entered into under the authority of the Governor in Council when the Minister for International Trade considers them to be in the national interest. These contracts are funded through External Affairs appropriations out of the Consolidated Revenue Fund and the related transactions are referred to as the Canada Account.

4.62 The contracts are often entered into at highly concessional terms, such as low interest rates and long periods of repayment. EDC and External Affairs officials informed us that concessional terms are established by international understanding. In some cases, countries which have received such loans have subsequently experienced some repayment difficulties. For example, a loan of $17.6 million was made in 1987-88 to an African country, at no interest for a 50-year repayment term. Loans of over $100 million to an East European country remain outstanding, without significant repayment for many years. There is an annual cost to Canadians resulting from the concessional loan terms, the losses likely to be incurred if loans are not fully repaid, and the continuing cost of administering these contracts.

4.63 Although the Minister for International Trade is ultimately accountable to Parliament, no reference to these moneys has been made by the Department in Part III of the Estimates. Thus, the Canada Account has not been considered a departmental program activity for which the Department is accountable. EDC, on the other hand, has stated that its accountability for the Canada Account is limited to ensuring that it is administered in a sound manner, and that the Corporation has not been required to provide justification for the moneys spent or to report on the overall net economic benefits to Canada arising from its activities. The Office of the Comptroller General acknowledges the need for appropriate disclosure to Parliament of all planned expenditures on export trade, and for reporting on their results, but has not provided specific recommendations or guidelines to either the Department of External Affairs or EDC.

4.64 We have been unable to determine which arm of the government is accountable for providing information to Parliament justifying moneys spent and stating the costs and benefits to Canadians of facilitating and developing export trade through the operations of the Canada Account.

4.65 Given the need for accountability to Parliament for the substantial public moneys relating to the Canada Account, its operations should be disclosed either as an activity of the Department of External Affairs -- and therefore included in its Part IIIs -- or as an activity of EDC in its Summary Corporate Plan, or by some other appropriate means to be determined by the government.

4.66 Officials of the Department of External Affairs have informed us that the Department and EDC believe that it would be useful to provide additional information to Parliament to enable it to understand this important program and that they and EDC will work together to achieve this objective.

Department of Finance - Duplicate Accounting Records for Public Debt

Accounting records for domestic public debt are maintained by both the Department of Finance and the Bank of Canada. We estimate that annual savings of about $100,000 could result from eliminating this duplication of records.

4.67 The Bank of Canada is the fiscal agent and registrar for the Government of Canada's domestic public debt, including Canada Marketable Bonds, Canada Savings Bonds and Treasury Bills. The Bank maintains records of the issuance and retirement of these securities, and the interest paid on them. In 1988-89, these transactions amounted to $545 billion.

4.68 The Department of Finance also maintains accounting records for these securities based on information provided by the Bank of Canada. The Department uses these records to calculate and record accrued interest for public accounts purposes. At year end, the accounting records of the Department and the Bank are reconciled.

4.69 In our opinion, there is no need to maintain duplicate accounting records. We estimate that eliminating this duplication could result in annual savings of $100,000. Accordingly, we believe that this situation should be reviewed.

4.70 Officials of the Department of Finance are currently reviewing this matter with officials of the Bank of Canada.

Department of Finance - Failure to Plug a Loophole in the Excise Tax Act Results in Increased Federal Sales Tax Rates and could have a Negative Effect on the Equity and Integrity of the Tax System

A key anti-avoidance rule in the Excise Tax Act is ineffective. The failure of the Department of Finance to correct the problem is causing annual revenue losses of at least $300 million that are being offset by increased federal sales tax rates.

4.71 A basic principle of Canadian tax law is that a taxpayer is entitled to arrange his or her affairs to attract the minimum amount of tax. This right is subject, however, to specific and general statutory anti-avoidance rules. Section 58 (formerly section 34) of the Excise Tax Act is an anti-avoidance rule. It is intended to discourage taxpayers from entering into non-arm's length transactions solely to gain a tax advantage.

4.72 The base for the federal sales tax is the selling price charged by the manufacturer. If the manufacturer is also responsible for research and development expenses, transportation costs, warranties, advertising and other marketing and distribution costs, then the selling price will include such costs. If, on the other hand, the manufacturer sells the goods to an agent or affiliated company that bears the responsibility for these associated costs, the manufacturer's selling price, which is the base for tax purposes, will be significantly lower.

4.73 Some manufacturers created marketing companies through which to sell their goods in order to gain a tax advantage. By using section 58 and setting the fair sale price of goods at the value for which the goods were sold to an arm's-length purchaser, the Minister of National Revenue was often successful in negating this tax advantage. However, the section is unable to upset a well-structured transaction.

4.74 A 1986 Federal Court of Canada decision confirmed that section 58 is ineffective in preventing manufacturers from avoiding tax by establishing related marketing companies.

4.75 Taxpayers are thus able to avoid tax in a way that was not intended. Although amendments to section 58 were made in 1988 to ensure that taxpayers are not able to set artificially low transfer prices to related marketing companies, the government still estimates that the avoidance mechanism is costing the treasury between $300 million and $350 million annually in lost revenue. In order to protect revenues, further legislative amendments are required.

4.76 In the June 1987 White Paper on Tax Reform, the government presented a proposal to deal with the problem. The proposal proved unworkable and was withdrawn in the February 1988 Budget. At that time the government presented a second proposal to proceed, effective 1 November 1988, with amendments to the Excise Tax Act. This proposal involved a complex method of adjusting all manufacturers' selling prices to take into account marketing and distribution costs in order to relieve the problem of tax avoidance and to correct the biases inherent in the Excise Tax Act.

4.77 Ultimately, in the April 1989 Budget the government announced that it would not close the loophole. The government stated that the problem would be eliminated with the introduction of the proposed new Goods and Services Tax on 1 January 1991 and that therefore it would not be reasonable to introduce the proposed changes, given the additional compliance and administrative burden they would entail and the short period before the introduction of the new tax. In the interim, the estimated $300 million to $350 million in lost annual revenue would be offset by increasing federal sales tax rates. Increased tax rates magnify the biases inherent in the Excise Tax Act; they also provide an additional benefit to taxpayers using the marketing company avoidance mechanism.

4.78 We are concerned that the government failed to correct an identified tax avoidance problem. The proliferation of marketing companies will cost the treasury at least $300 million a year until at least 1 January 1991. The ability to rectify problems through timely legislative action is critical to the administration of a commodity tax system because retroactive legislation can impose serious hardships.

4.79 We are also concerned because tax avoidance schemes have a negative effect on the equity and integrity of the tax system and on attitudes to voluntary compliance. Access to such schemes is usually restricted to those who can afford expensive start-up and running costs.

Department of Finance - Non-compliance with the Financial Administration Act

During 1988-89, the Department of Finance failed to obtain Governor in Council approval, as required by the Financial Administration Act, for the issue of $2 billion in Treasury Bills.

4.80 Borrowing authority Acts provide Parliamentary authority for the net amount of new debt issues, less redemptions, during a fiscal year. The Financial Administration Act provides additional controls over the financing of the debt. Under sections 44 and 46 of the Act, Governor in Council approval is required for the issue of the various types of financial securities.

4.81 While the overall new borrowings authorized for 1988-89 were not exceeded, the Department of Finance failed to obtain the required Governor in Council approval for the issue of $2 billion in Treasury Bills during the first quarter of 1988-89.

4.82 Officials of the Department of Finance informed us that this situation stemmed from an unexpectedly large rollover of Treasury Bills during the first quarter of the year. New procedures have since been implemented to prevent further recurrence.

Department of Regional Industrial Expansion - Serious Deficiencies in the Approval Process and Administration of Two Contributions Totalling $27.7 Million

In June 1988, the Department of Regional Industrial Expansion (DRIE) made a payment of $238,000 to a defence electronics company. This was the final payment of a $13.3 million repayable contribution for an avionics displays project funded under the Defence Industry Productivity Program (DIPP). In May 1989, $6.3 million was paid to the same company as part of another repayable contribution of $14.4 million for a related project funded under DIPP. We observed a number of serious deficiencies in the approval process for these projects. Subsequent project administration and monitoring were also inadequate.

4.83 A $6.2 million repayable contribution for phases A and B of a project was originally approved by the DRIE Minister on 12 February 1986. An amendment to the project, approved by the Minister on 19 March 1987, increased the contribution by $7.1 million, bringing the total to $13.3 million. This was beyond the $10 million authority delegated to DRIE, making Treasury Board approval a requirement. This approval was not obtained. Documentation submitted to the Minister for approval of the $7.1 million amendment did not indicate that it would bring total DIPP funding to over $10 million.

4.84 On 9 March 1989, DRIE obtained Treasury Board approval for a $14.4 million repayable contribution to the same company for a related project. There was a considerable amount of information contained in the project documentation to indicate that it was a continuation of the previous project. This contribution increased the total DIPP funding to $27.7 million. Although funding in excess of $20 million to one company for continuation of a project requires Cabinet approval, it was not sought because this contribution was treated by DRIE as a separate project.

4.85 To be eligible for assistance, a project must need DIPP support in order to proceed. DRIE documentation on the initial project in January 1986 indicated that the project had been under way since April 1984 because the company did not want to miss business opportunities. The project analysis did not explain how the project could be considered eligible in these circumstances. A project audit, carried out by the Audit Services Bureau (ASB) of the Department of Supply and Services (DSS), indicated that the company had begun work on the project as early as February 1983 and that some sales had occurred prior to July 1985.

4.86 The project summary dated August 1988 for the second contribution of $14.4 million indicated that this project would go ahead without DIPP funding, although the company might then miss anticipated market opportunities and have t drop other lesser projects. Other documentation indicated that work on this project had started in August 1987 in order to take advantage of these markets.

4.87 For both projects, DRIE allowed the company to claim retroactive reimbursement for costs incurred. This did not appear to be consistent with the directive governing retroactivity in the administration of DIPP which permits retroactivity to the date DRIE receives full disclosure of information on a project.

• The first project was approved 12 February 1986, although the final proposal was received by DRIE in March 1986. This proposal referred to an original submission in March 1985. Costs were allowed retroactive to 1 April 1984.
• In the second project, DRIE had received a draft proposal dated 20 January 1988. The application and final proposal for funding were received on 8 April 1988. This project was approved on 9 March 1989. Retroactivity was allowed to 1 March 1988 -- the day after the company had reached the maximum costs allowed under the first project.

4.88 Under the contribution agreement, proceeds from sales are to be deducted from eligible costs. The agreement also states that the company's records of costs and sales are to be open to audit. In an audit report to DRIE in November 1987, ASB indicated that sales had taken place before July 1985 and that the company had denied the auditors access to sales records. It was therefore impossible to determine the total possible overpayment by DRIE. No action was taken by DRIE even though this denial of access meant that the company was in default of its contract. ASB repeated its audit qualification in May 1989.

4.89 The company was also required to report sales resulting from work funded under the agreement. No indication was found on file that the company had informed DRIE of sales that occurred prior to July 1985. There were other indications on file of sales from August 1985 to July 1987 but DRIE had not followed these up to determine why the company had reported a zero dollar sales figure for this period.

4.90 We also observed that some key information provided during the decision-making process for the $14.4 million repayable contribution was inaccurate and incomplete.

• The project proposal sent to the Minister requested DIPP funding for 50 percent of project costs. The documentation referred to two previous projects for which DIPP contributions had represented 50 percent of project costs. In fact, the level of DIPP funding for these projects had been less. The $6.2 million contribution represented 35 percent of project costs and the amendment for $7.1 million represented 42.5 percent of costs. A contribution for a $2.9 million capital project had also been funded at 35 percent of costs.
• Potential sales referred to in the proposal to the Minister and in the Treasury Board submission were considerably higher than the projections in the company's final proposal.
• In the Treasury Board submission, DRIE indicated that the company had never paid out any dividends. This was not the case. A $4.2 million dividend was paid in 1987 from 1986 profits.

4.91 The $14.4 million contribution was to be fully repayable, based on a percentage of sales of all display products. The wording of the contract entered into for this contribution called for repayment to begin after the initial $6.2 million project and $7.1 million amendment had been fully repaid. However, we observed that the contract for the first project called for repayment to begin only after $25 million in annual sales of products specifically included in the contract had been reached. The wording of these repayment clauses could result in non-repayment of the contributions, particularly if sales from the first contract are lower than expected.

4.92 The first contribution, totalling $13.3 million, has been fully paid to the company. Any DRIE overpayment will have to be recovered. An overpayment of $314,000 has been identified by ASB. Repayment has been requested by DSS.

4.93 DRIE has reviewed our observations and re-examined these projects. Documentation has been prepared which describes the technical specifications to be met by the product under the second project and those the company had achieved by March 1988. DRIE is satisfied that, although the two projects are closely linked, these specifications are different enough that the projects were separate. In terms of the need for DIPP support, DRIE has indicated that the $14.4 million contribution was essential if the company was to meet the minimum technological requirements on time to take advantage of major market opportunities. Although DRIE has indicated that, in its opinion, the projects were separate and eligible for DIPP funding, it has acknowledged that the documentation and analysis supporting these projects were inconsistent and lacking in a number of areas.

4.94 With respect to retroactivity, DRIE has also indicated that it believes the retroactive costs in both projects were appropriately allowed although these were not adequately supported by information on file.

4.95 The issue of access by ASB to sales information is being addressed, as is the recovery of the overpayment. One repayment of $160,517 has been received and a second is under negotiation. DRIE has also advised us of its intent to seek a contract amendment to clarify the original intent of the parties that all product sales be considered with respect to repayment.

Department of Supply and Services - Difficulties in the Acquisition of Crash Firefighting and Rescue Vehicles

In 1986, the Department of Supply and Services (DSS) entered into procurement contracts to provide the Department of Transport (DOT) with crash firefighting and rescue vehicles for use at airports operated by DOT. The contracts were for 68 Rapid Intervention Vehicles (RIVs) costing $22.1 million.

According to information in DSS and DOT files, this acquisition encountered significant difficulties. The consequences included:

• additional costs of approximately $1 million arising from the initial splitting of the contract requirement between two suppliers and the subsequent reversal of this arrangement;
• a government payment of $290,000 to terminate a contract with one of the suppliers; and
• a time span of over four years to complete a procurement of equipment that was urgently needed for public safety.

4.96 We noted considerable delays in awarding the RIV contract. Although DOT's request for the vehicles was made in the period January to July 1984, the first contract -- for 34 vehicles -- was not awarded by the government to Supplier A until April 1986. A second contract -- for the remaining 34 vehicles -- was not awarded to Supplier B until September 1986.

4.97 The contract requirement was split and awarded to two suppliers despite DSS and DOT concerns in 1986 that Supplier B might not have had the necessary capabilities to perform the work. As well, DOT officials had expressed their preference for awarding the entire project to Supplier A, who it was believed had the appropriate expertise. We were advised by Supplier B that it had the full capability to complete the work.

4.98 By splitting the requirement, the government sought to achieve other objectives, namely, to reduce the risk of late deliveries -- because of the urgency of the need for the vehicles -- to create a second source of supply, to encourage technological development, and to create additional employment opportunities. As a result of splitting the contract requirement, the total contracted price for all the required vehicles amounted to $22.1 million instead of $20.2 million, the amount initially bid by Supplier A.

4.99 Eight months after signing, Supplier B advised the government that it could not perform in accordance with the contract and requested that the contract be terminated by mutual consent. Subsequently, Supplier B advised us that it had to terminate this contract due to difficulties in dealing with government officials at that time.

4.100 Under the Termination for Default provisions of the contract, the government could have terminated it 45 days after giving notice to the supplier of its default. Instead of applying this provision, the government paid Supplier B $290,000 and released it from the contract. DSS indicated that this payment was made to enable the supplier to maintain its financial viability. In addition, DSS stated that this payment would allow it to accept a time-limited offer from Supplier A for the production of all units originally assigned to Supplier B.

4.101 Finally, in May 1987, Supplier A's initial contract for 34 vehicles was extended to include the entire requirement for 68 vehicles at a cost of $21.3 million, approximately $1 million higher than its original bid of $20.2 million for the 68 vehicles.

4.102 In 1983, DOT had indicated, in its funding request for this procurement, that its current standards of crash firefighting and rescue services dated back to 1962 and related to aircraft of a bygone era. DOT had determined that there was an urgent need to replace its existing vehicles which did not meet the revised standards of the International Civil Aviation Organization. This urgency was expressed to DSS at various points in the procurement process.

4.103 Despite this urgency, more than four years elapsed between DOT's requisition for the vehicles and the date the deliveries were completed in 1988. DSS advised us that, in its opinion, the technical sophistication of the vehicles prevented an earlier completion of the procurement.

4.104 Nevertheless, we are concerned that the protraction of this project could have had an impact on public safety. We believe that any urgent procurement involving significant safety equipment should be completed more expeditiously.

Department of Supply and Services and Department of Fisheries and Oceans - Unacceptable Contracting Practices

Unacceptable contracting practices in the acquisition of computer services resulted in a dispute with the supplier over the adequacy of the fees paid.

4.105 In 1987, the Department of Supply and Services (DSS) contracted for computer processing and support services relating to a financial management system (FMS) for the Department of Fisheries and Oceans (DFO). The contract, as amended in 1988, provided for the services at a fixed monthly fee of $50,000, for five months with an option to extend the contract for any period up to three months beyond the expiration date.

4.106 Before the contract ended, DSS became aware that a continuation of services would be needed after the expiration date. In response to a request from DFO, DSS asked the supplier to extend the contract for an additional month under the same terms and conditions. However, neither DSS nor DFO gave the notice within the time required to take up the contract option and accordingly, the contract expired.

4.107 Notwithstanding the expiration, the supplier continued to provide service even though it had expressed concern over the increased workload and costs for the project. A dispute then arose and the supplier claimed compensation of $671,000 for the one month extension requested by the departments, and submitted another claim for $615,000 to cover an apparent increase in the workload during the initial five months of the contract.

4.108 We were advised by DSS and DFO that the workload was indeed larger than had been envisaged by the contract. DSS and DFO negotiated a final settlement of the dispute, and of all claims, with the supplier for $250,000 and amended the contract accordingly. However, this amendment, made in the new fiscal year, stated that the payment of $250,000 was for additional services provided during the month of June 1988 --within the optional extension period provided for in the original contract. DSS informed us that DFO was unable to amend its contract requisition to take advantage of the option. DFO acknowledged that the additional services had thus been rendered without a bona fide contract in place.

4.109 In our view, the performance of additional work by a supplier without proper contract documentation and the failure to take advantage of a contractual option within the required time limits constitute unacceptable contracting practices, which in this case resulted in a dispute.

Departments Need to Reconcile their Financial Records with the General Ledger of Canada on a More Timely Basis

A significant number of departments have been unable to reconcile their financial records with the General Ledger of Canada on a timely basis. Without timely reconciliations, the reliability of financial information may be questionable and there is an increased risk of errors or omissions.

4.110 Reconciliation is a fundamental accounting control that helps ensure that financial information used by departments for managing agrees with financial information in the General Ledger of Canada used for external reporting. The purpose of reconciling is to detect incomplete or inaccurate information. Reconciliations and other accounting controls are the responsibility of departmental Senior Financial Officers.

4.111 The requirements for timely reconciliations are set out in the Guide on Financial Administration issued by the Office of the Comptroller General and in Receiver General Directives. The Receiver General Directive on Reconciliation was revised as recently as 1987. Most departments have not met the revised reporting requirements. Most failed to reconcile their Payment on Due Date (PODD) liability accounts and more than half of all departments were late filing their monthly reconciliation reports. Some departments were not able to reconcile until well after the year end and in other cases reconciliation reports contained unexplained and uncorrected differences.

4.112 Several of the government's largest departments have recently spent significant amounts of money to install new computer systems to provide management with more sophisticated accounting and internal financial reporting. Reconciling the information in virtually all of these systems with the General Ledger of Canada has proven difficult. In terms of timeliness and quality of reconciliations, the most serious deficiencies arose in these new systems.

4.113 In examining and reporting on the Financial Statements of the Government of Canada (see Section 2, Volume I of the Public Accounts) we were required to perform additional audit procedures because we could not rely on the financial systems to produce complete and accurate information. Although we have not detected material errors affecting Canada's summary statements, there is still a risk that financial information used in the departments concerned may have been inaccurate and thus misleading to those who used it.

4.114 The Office of the Comptroller General is responsible for providing advice and guidance to departments on financial control. Their recent technical publication, Common Evaluation Criteria for Financial Management Systems, intended as a guide for the selection of new financial systems, excludes from the "mandatory" category computerized reconciliation with the General Ledger of Canada. These criteria should be reviewed and amended to ensure that the requirement for reconciliation procedures receives top priority. In addition, departmental Senior Financial Officers should ensure that their financial information systems are agreed monthly with related balances in the General Ledger of Canada, as already required by Receiver General directive.

4.115 The Office of the Comptroller General and the Receiver General, in conjunction with departments, are undertaking several initiatives to ensure that all departments will in future be able to meet the requirements for timely reconciliations. These initiatives include reviewing the Common Evaluation Criteria, preparing a handbook on reconciliation to be issued by year-end, ensuring new computer systems include reconciliation modules and exploring ways of getting reconciliation data to the departments more quickly.

4.116 Until timely reconciliations are regularly performed, there is no assurance that departmental accounting systems can be relied on for financial and management decision making and external reporting.